Giving Wings to Your Leadership Style Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Giving Wings to Your Leadership Style case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Giving Wings to Your Leadership Style case study is a Harvard Business School (HBR) case study written by Claudia Peus. The Giving Wings to Your Leadership Style (referred as “Humanistic Leadership” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Organizational culture.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Giving Wings to Your Leadership Style Case Study

Many managers argue that, in principle, they would like to give employees more room for development and creativity, but given the urgent challenges resulting from the instability of domestic and global financial markets, they must focus on efficiency and cost cutting instead. But do humanistic principles and superior business performance really contradict each other? This article looks at some humanistic leadership principles underpinning successful organizations. It offers guidelines for managers on how humanistic leadership can renew an organization's direction, structure and capabilities, while also winning over employees, whose support is critical for success. The author suggests the factors that are hugely important for managing organizational change initiatives effectively. Finally, she summarizes existing research indicating that humanistic or ethically oriented leadership - often termed transformational leadership - can be linked to positive economic performance.

Case Authors : Claudia Peus

Topic : Leadership & Managing People

Related Areas : Organizational culture

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Calculating Net Present Value (NPV) at 6% for Giving Wings to Your Leadership Style Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027932)	-10027932	-	-
Year 1	3459099	-6568833	3459099	0.9434	3263301
Year 2	3973906	-2594927	7433005	0.89	3536762
Year 3	3957816	1362889	11390821	0.8396	3323059
Year 4	3250691	4613580	14641512	0.7921	2574852
TOTAL			14641512		12697974

The Net Present Value at 6% discount rate is 2670042

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Internal Rate of Return
3. Net Present Value
4. Profitability Index

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Humanistic Leadership have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Humanistic Leadership shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Giving Wings to Your Leadership Style

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Leadership & Managing People Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Humanistic Leadership often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Humanistic Leadership needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10027932)	-10027932	-	-
Year 1	3459099	-6568833	3459099	0.8696	3007912
Year 2	3973906	-2594927	7433005	0.7561	3004844
Year 3	3957816	1362889	11390821	0.6575	2602328
Year 4	3250691	4613580	14641512	0.5718	1858593
TOTAL					10473677

The Net NPV after 4 years is 445745

(10473677 - 10027932 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10027932)	-10027932	-	-
Year 1	3459099	-6568833	3459099	0.8333	2882583
Year 2	3973906	-2594927	7433005	0.6944	2759657
Year 3	3957816	1362889	11390821	0.5787	2290403
Year 4	3250691	4613580	14641512	0.4823	1567656
TOTAL					9500298

The Net NPV after 4 years is -527634

At 20% discount rate the NPV is negative (9500298 - 10027932 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Humanistic Leadership to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Humanistic Leadership has a NPV value higher than Zero then finance managers at Humanistic Leadership can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Humanistic Leadership, then the stock price of the Humanistic Leadership should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Humanistic Leadership should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Giving Wings to Your Leadership Style

References & Further Readings

Claudia Peus (2018), "Giving Wings to Your Leadership Style Harvard Business Review Case Study. Published by HBR Publications.